SM Energy Company — Q2 2012 Form 10-Q
Business context and period. Unaudited results for the quarter and six months ended June 30, 2012. SM Energy is an independent onshore oil and gas producer, focused on oil- and NGL-rich plays, including the Eagle Ford and Bakken/Three Forks.
Financial and operating performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Oil, gas and NGL production revenue | $312.6m | $333.9m | $675.2m | $610.2m |
| Net income | $24.9m | $124.5m | $51.2m | $106.0m |
| Diluted EPS | $0.37 | $1.86 | $0.76 | $1.59 |
| Operating cash flow | Not separately provided | Not separately provided | $410.3m | $370.0m |
| Capital expenditures | Not separately provided | Not separately provided | $705.4m | $662.4m |
- Q2 production averaged 555.7 MMcfe/day, up 27% year over year; first-half average production was 556.4 MMcfe/day, up 33%.
- Q2 realized equivalent price fell 26% to $6.18/Mcfe. Oil, gas and NGL realized prices were $82.52/Bbl, $2.34/Mcf and $37.79/Bbl, respectively.
- Q2 operating income was $52.4m, versus $211.7m; total operating expenses rose to $252.0m from $166.2m. The filing reports no consolidated gross-margin measure.
- First-half investing cash outflow was $695.2m; financing cash inflow was $165.9m. Capital expenditures exceeded operating cash flow by approximately $295.1m.
- Cash was $0.2m at quarter-end, versus $119.2m at year-end 2011. Current assets were $334.2m and current liabilities $475.8m.
- Debt at June 30 included $61m drawn on the credit facility and $1.1bn of senior notes; the convertible notes had been settled. Credit-facility availability was $938.2m at June 30 and $913.7m at July 27. Debt/EBITDAX and adjusted current ratios under the credit agreement were 1.2 and 2.6, respectively; the company reported covenant compliance.
Material changes and unusual items
- Production growth was driven principally by Eagle Ford development and increased Bakken/Three Forks output, but lower commodity prices more than offset volume growth in Q2 revenue.
- Q2 included a $38.5m impairment of Haynesville proved properties, attributed to lower natural-gas prices, and a $28.3m loss after certain Rocky Mountain properties ceased to qualify as held for sale. First-half divestiture activity showed a $22.7m loss, compared with a $54.9m gain in the prior-year period.
- Reported Q2 results included a $98.1m derivative gain, largely reflecting falling commodity prices, and a $22.1m noncash benefit from a reduction in the Net Profits Plan liability. These items materially affected reported earnings.
- In June, SM Energy issued $400m of 6.50% senior notes due 2023, receiving $392.3m net proceeds, used to reduce credit-facility borrowings. It also paid $287.5m to settle the 3.50% convertible notes, primarily in cash.
Outlook, management commentary and risks
- Management forecast a 2012 capital program of approximately $1.5bn, including $1.1bn–$1.2bn for drilling and completions; more than 95% of allocated drilling and completion capital was expected to target oil- and NGL-rich projects.
- Operated Eagle Ford drilling and completion spending guidance was reduced to $520m–$570m from $650m–$700m, mainly because gathering constraints delayed completions. Management reported tank-battery installation delays and inadequate compression in a third-party-operated midstream system.
- Management expected operating cash flow and divestiture proceeds to fund most of the capital program, with credit-facility borrowing funding the remainder. It cited commodity-price volatility, service-cost inflation, borrowing-base sensitivity and gathering/transportation capacity as key uncertainties.
- The company had $551.7m remaining under Mitsui’s $680m development carry as of June 30; the carry funds 90% of certain drilling and completion costs on specified non-operated Eagle Ford acreage.
- SM Energy said it expected no federal income taxes for 2012 based on its Q2 projections. This is an expectation, not a guarantee.
- In a Texas overriding-royalty dispute, an appeals court reversed a prior judgment against the company; plaintiffs could seek review by the Texas Supreme Court. The company also pursued litigation against Endeavour over a proposed Pennsylvania asset purchase and was remarketing those assets.
- Management warned that new derivatives regulations could increase costs or cash-collateral requirements. The filing also identifies commodity-price, reserve-replacement, drilling, environmental, counterparty and financing risks. Management stated disclosure controls were effective at a reasonable-assurance level.
Investor verification priorities
- Assess how much reported earnings depended on derivative fair-value gains and Net Profits Plan estimates, and distinguish these from realized operating cash generation.
- Track whether Eagle Ford gathering constraints ease, delayed completions proceed, and production and unit transportation costs meet management expectations.
- Confirm delivery of the $1.5bn capital plan and funding assumptions, including credit availability and the October 2012 borrowing-base redetermination.
- Monitor realized oil, gas and NGL prices, hedge volumes and terms, and the effects of hedges on future cash flows.
- Follow the Endeavour/Pennsylvania asset-sale dispute and any further appeal in the overriding-royalty litigation.